Don't let it get away!

Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as fetching as they may appear. Let's see which smaller companies in the asset management industry offer the most promising dividends.

As my colleague Matt Koppenheffer has noted: "Between 2000 and 2009, the average dividend-adjusted return on stocks with market caps above $5 billion and a trailing yield of 2.5% or better was a whopping 114%. Compare that to a 19% drop for the S&P 500."

When hunting for promising dividend payers, unsophisticated investors will often just look for the highest yields they can find. While these stocks will indeed pay out the most, the yield figures apply only for the current year. Extremely steep dividend yields can be precarious, and even solid ones are vulnerable to dividend cuts.

When evaluating a company's attractiveness in terms of its dividend, it's important to examine at least three factors:

The current yield

The dividend growth

The payout ratio

If a company has a middling dividend yield, but a history of increasing its payment substantially from year to year, it deserves extra consideration. A $3 dividend can become $7.80 in 10 years, if it grows at 10% annually. (It will top $20 after 20 years.) Thus, a 3% yield today may be more attractive than a 4% one, if the 3% company is rapidly increasing that dividend.

Next, consider the company's payout ratio, which reflects what percentage of income the company is spending on its dividend. In general, the lower the number, the better. A low payout ratio means there's plenty of room for generous dividend increases. It also means that much of the company's income remains in its hands, giving it a lot of flexibility. That money can fund the business's expansion, pay off debt, buy back shares, or even buy other companies. A steep payout ratio reflects little flexibility for the company, less room for dividend growth, and a stronger chance that if the company falls on hard times, it will have to reduce its dividend.

Peering into asset managersMany asset managers are organized as business development companies, which pass through their income in the form of dividends to their shareholders. TICC Capital (Nasdaq: TICC) , MCG Capital (Nasdaq: MCGC) , and BlackRock Kelso Capital (Nasdaq: BKCC) are among the highest-yielding stocks in the group, recently offering 12%, 16%, and 11%, respectively. But their payouts can be volatile. TICC's dividend has gone up and down in recent years, while MGC Capital's dividend is less than half of what it was five years ago, and its earnings have been negative recently. BlackRock Kelso's dividend has also fallen recently. They're not necessarily bad investments -- TICC, in particular, sports five stars (out of five) in our CAPS community, providing financing to technology companies. Still, these companies' dividends aren't entirely reliable.

Some asset-management companies, such as American Capital (Nasdaq: ACAS) , don't pay dividends at all. American Capital actually did pay a dividend until a few years ago, but it has recently been plowing capital into share buybacks, spending millions buying back stock in a way that might not be its best move.

Just rightAs I see it, Prospect Capital (Nasdaq: PSEC) , which focuses on private equity and mezzanine financing for up-and-coming businesses, offers a solid combination of dividend traits. With a yield of about 11%, the company's payout ratio is lower than many of its peers. Moreover, its revenue and earnings are growing, suggesting that it shouldn't have too much trouble keeping up its hefty payout.

Of course, as with all stocks, you'll want to look into more than just a company's dividend situation before making a purchase decision. Still, these stocks' compelling dividends make them great places to start your search, particularly if you're excited by the prospects for this industry.

Comments from our Foolish Readers

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I'll give you guys credit for keeping with your complete miss on the ACAS buyback. Still buying at way below NAV. The stock is up over 30% this year. I sure hope most others are ignoring your lack of any intelligent analysis on ACAS. Their buyback has made shareholders much better off than he divvy would have.

I am a BDC fan. It is always a good thing when you can offer financing, give guidance and also keep some "skin in the game". I own several BDCs and am always looking for more provided the sector is attractive and the income yield is high enough. As an example, the Horizon Technology Finance Corp. (HRZN ) specializes in health devices, etc. and pays a quarterly cash dividend yield of about 10%. Others like it are: PSEC, BKCC, and HTGC.

Sending report...

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter... Follow @SelenaMaranjian